Posts Tagged ‘accounts payable days’

If you read my postings on a regular basis I may sound like a broken record with how much I focus on cash. But again, as I’ve said before, “Profit is nothing until it is converted to cash.” See Cash Flow – The Bottom Line. Now I want to delve into how efficiently we convert financial activity to cash.

I’ve written extensively about how important cash is to a business. The accounts payable days analysis is an indicator of how well you are managing cash. This measure is also known as the days payable outstanding.

Are Your Vendors Happy?

We all know how important it is to keep customers happy. Don’t meet their needs or make them mad and they may leave you. Even worse, their comments may cause others to leave with them. Just like customers, you also need to keep vendors happy. If you don’t you may find your credit line cutoff and that you cannot get essential products and services. Imagine what happens when you cannot get the product you need to sell or use in your manufacturing process. Pretty soon it impacts your company’s ability to satisfy customers. The accounts payable days analysis is a statistic you can calculate that indicates how good of a job you are doing managing accounts payable and keeping your vendors happy.

The Calculation

The calculation is straight forward using the formula:

(Accounts Payable / COGS) * 365 where COGS is cost of goods sold.

Granted that the COGS does not include every expense that goes through accounts payable, but this is the basic formula. With that said, let’s look at an example of the accounts payable days analysis. If your accounts payable balance is $500,000 and your annual cost of goods sold is $2,000,000 the calculation is:

($500,000 / $2,000,000) * 365 = 91.25 days. This seems like a lot, but it is important to consider your industry’s average days for paying vendors. If the industry average is 120 days, then by comparison your company does not look that bad. On the other hand, if the industry average is 45 days then this is an indication you may be getting ready to experience difficulties with your vendors if you haven’t already. Of course the days payable outstanding is only one thing to consider. Your company may not have the financial clout of your competitors and vendors may keep you to a tighter leash. If so, you will need to earn their trust. Basically, managing accounts payable should be made a priority. Unfortunately, like the balance in the cash account, the issue is not with the accounts payable account itself. The balance in this account is the result of activity in other areas.

Some Causes and Solutions

Probably the three biggest causes of the accounts payable days analysis being too many days are the following:

Too much inventory or the wrong mix of inventory, thus having too many days of inventory supply

Too many days of accounts receivable outstanding, resulting in not realizing cash from sales in a timely manner

All that said, the quickest ways to get accounts payable under control is to address the accounts receivable days outstanding and the days of inventory on hand. With accounts receivable this involve your customer credit policies and staying on top of collections. With inventory you will need to analyze the balance on hand by item and see which items are overstocked. With both accounts receivable and inventory you can use the 80/20 rule to help you decide where to start. See the blog posting 80/20 Rule for Receivables Management for how this works with accounts receivable.

Next Steps

I encourage you to make the accounts payable days analysis to see just how well you are doing. AimCFO is here to help if you need it or are just not sure how to go about this process.